Equity contributions to corporate LBOs in the syndicated loan market this year have exceeded 50% for the first time on record, underscoring the impact of high borrowing costs that are eroding interest coverage and fueling concerns about potential strains on leveraged balance sheets.
However, despite the amplified credit risk curbing investor tolerance for leverage, M&A and LBO activity jumped to a 17-month high in September, providing optimism that the funding market for dealmaking will continue ramp up.
Some key findings from LCD’s analysis of the credit stats of LBO deals clearing the syndications market so far this year:
- Yields on new LBO loans are 11%, a record high
- Corporate buyout leverage has fallen to an 11-year low
- Equity contributions top 50% for first time on record
- Cash interest coverage on M&A debt at an all-time low
Starting with leverage, LCD’s compilation of company financials at the time of issuance show the average debt/EBITDA ratio of newly minted US broadly syndicated LBO debt fell to 4.71x for large corporate borrowers — the lowest quarterly reading since 2012.
This brings the year-to-date average leverage for these LBO loans to 5.18x, the most conservative for buyout lending in the comparable period since 2012, and for full-year readings since 2010. Note that new loan issuance backing LBO transactions in 2023 through Sept. 30 is at a low point since 2010.
In recent years, low financing costs allowed companies to load up on debt without a material deterioration in service coverage, but cash interest coverage since the start of the Fed’s rapid pace of rate hikes in 2022 has fallen markedly.
Cash interest coverage on debt backing LBO transactions in Q3 thinned to 2.24x, from 2.87x in Q2. In the first quarter of 2022, just before the Fed embarked on its aggressive interest-rate-hiking cycle, this metric was nearly 1.5x higher, at 3.72x.
Year to date, cash interest coverage at 2.4x is the lowest since 2007.
Looking at M&A activity more broadly, with debt issuance for M&A and LBO deals increasing to a five-quarter high in Q3, the average leverage ratio crept up nearly 20 basis points, to 4.87x. It did, however, remain below 5x for a second quarter in a row. Year to date, the debt/EBITDA ratio of newly issued M&A debt is 4.89x, down significantly from 5.73x in 2022.
Cash interest coverage for all M&A-related debt in the third quarter, at 2.35x, was down from 2.93x in the second quarter. It was 3.73x in the first quarter of 2022. Year to date, cash interest coverage at 2.6x is the lowest reading on record.
The shift in risk tolerance demonstrated by the drop in leverage levels is also seen in the rapidly changing ratings profiles of LBO borrowers in the syndicated loan market.
So far this year, only 11% of these LBO borrowers carried a B-minus rating. In 2021 and 2022, the B-minus shares of deal ratings were 52% and 41%, respectively.
New LBOs with higher ratings include Worldpay, which carries an issuer rating profile of BB/Ba3/BB. Bucking this trend, Fogo de Chão, with a B-/B3 rating, offered a 55% equity contribution to see its deal over the finish line.
With high debt costs impacting purchasing power, the average purchase price multiple for US LBOs in the third quarter was just 9.3x, according to LCD. That sits below all full-year readings since 2013.
Halcyon days
In addition to lowering purchase price multiples, high debt costs are also forcing private equity firms to cough up more of their own cash. Through Sept. 30, equity contributions for LBO transactions jumped to 51%, the first time in LCD’s history of tracking this metric (since 1997) that sponsors have offered an equity infusion of more than half the funding mix. In the halcyon days for PE shops of (mostly) lower interest rates, the average equity contribution in the 10 years through 2021 was 41%.
As for LBO loan pricing, the dramatic jump in the underlying base-rate compensation has favored lenders, helping to raise the average yield to maturity on LBO loans in the third quarter above 11% for the first time on record. Over the entire first three quarters of the year, the average yield is 10.7%.
Learn more about our editorial standards.
